Market capitalisation and enterprise value

Market cap prices the equity; enterprise value prices the whole business, adding what is owed and subtracting the cash. The formula, the size categories, and a worked example.

9 min read workbook 3.1.6 to 3.1.7chapter worth 2 marks10-question quiz below
ExamA near-certain numerical: EV from market cap, debt and cash. Remember to add debt and preferred capital and subtract cash and non-operating investments. The trap is subtracting debt or adding cash.

Market capitalisation: the price of the equity

Market capitalisation is the value the market's participants collectively place on the entire company, as reflected in the current share price. Multiply market price per share by the total number of outstanding shares. A company with one lakh shares trading at 20 rupees has a market cap of 20 lakh. As the price moves, so does market cap, continuously.

Exam trapOutstanding means issued, subscribed and fully paid up

The share count in the formula is the shares actually out in the world. Authorised share capital, the maximum the company is permitted to issue, is a different and larger number and must not be used.

Size categories

Traded stocks are commonly sorted by market cap.

Large cap
The largest companies by market cap. Their size attracts a large investor base, so both retail and institutional investors enjoy high liquidity. Most blue-chip stocks are large caps; blue-chip status rests on a long history, stable profits, market share and profitability.
Mid cap
Medium-sized by market cap, with a good level of liquidity.
Small cap
Smaller companies that do not enjoy much liquidity.

There is no fixed cut-off. A common convention treats the top 50 to 100 stocks by market cap as large, the next 200 to 500 as mid, and everything else as small. The threshold floats with the market, the period and any regulatory definition in use. Market cap also serves at country level: the ratio of total market cap to GDP measures the size and importance of a country's stock market.

Enterprise value: the price of the whole business

Market cap prices only the equity. A business is financed by several kinds of capital, and enterprise value (EV) captures the value of all the capital gainfully employed in it. The idea is to add every claim on the business and subtract the cash that is not needed to run it.

Formula · Enterprise value, standalone

EV = Market value of common equity + Market value of preferred capital + Market value of debt - (Cash, cash equivalents and non-operating or non-strategic financial investments)

  • Market value of common equity is the market capitalisation.
  • Debt and preferred capital are added because they are claims that a buyer of the whole business would have to honour.
  • Cash and non-operating investments are subtracted because a buyer would receive them, which reduces the effective price.

On a consolidated basis, the parent's numbers are joined by the value of non-controlling interest and by the subsidiaries' preferred capital and debt, with the subsidiaries' cash and non-operating investments subtracted along with the parent's.

Every component should be at fair market value. Unlisted preferred shares and bank debt rarely have an observable fair value, so the syllabus allows balance sheet values as a proxy when fair value is unavailable or cannot be determined.

Worked exampleThe worked EV

A company has 10,00,000 shares of face value 10, trading at 340. Its balance sheet shows preferred capital of 8.5 crore and debt of 6.4 crore, both unlisted and carried at amortised cost, cash and equivalents of 2.5 crore and financial investments of 1.4 crore at fair value. The common equity line on the balance sheet reads 12.5 crore, and that number is irrelevant: market cap is 340 times 10 lakh, which is 34 crore. With balance sheet values standing in for the unlisted items, EV is 34.0 + 8.5 + 6.4 - 2.5 - 1.4 = 45.0 crore.

RememberThe three-line version

Most exam numericals give only market cap, debt and cash. EV equals market cap plus debt minus cash. Market cap 10 lakh, debt 3 lakh, cash 4 lakh: EV is 9 lakh. A cash-rich company can have an EV below its market cap, and that is not an error.

Exam trapThe signs

Debt is added. Cash is subtracted. The wrong options in an EV question are almost always the three other sign combinations. If your answer is below the market cap when the company has more debt than cash, you subtracted the wrong thing.

Take these into the exam
  • Market capitalisation is market price per share times outstanding shares (issued, subscribed and fully paid; not authorised capital). It changes continuously with the price.
  • Large caps are the largest and most liquid, most blue chips are large caps; mid caps are medium with good liquidity; small caps are small and less liquid. Cut-offs are floating: roughly top 50 to 100 large, next 200 to 500 mid, the rest small.
  • Enterprise value, standalone: market value of equity plus preferred capital plus debt, minus cash, cash equivalents and non-operating financial investments. Consolidated adds non-controlling interest and the subsidiaries' preferred capital and debt, and subtracts their cash and investments too.
  • Use fair market values; where unlisted securities or bank debt have no observable fair value, balance sheet values stand in as a proxy.

Check yourself

Answer without looking back. Misses go to your mistake notebook and come back in revision.

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Face, book, market, replacement and intrinsic value
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Earnings, EPS and DPS
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